Deductions are great because they lower your tax bill from the Internal Revenue Service, but the topic can be confusing due to recent legislation and the overall complexity of the tax system.
What Are Itemized Deductions?
According to the IRS, “deductions reduce the amount of your taxable income.”
You can take deductions in 1 of 2 ways: a standard deduction, which is a flat deduction based on your income, tax filing status, and other factors; or you can itemize deductions, meaning you deduct the specific amounts you’ve paid through the tax year for qualifying expenses.
Importantly, both of these types of deductions are known as “below-the-line” deductions, meaning they come out of your adjusted gross income (AGI). They are different from “above-the-line” deductions, such as self-employment expenses and interest paid on student loans.
Why Should I Care?
Deductions functionally lower your tax bill, so this part of your tax preparations is extremely relevant to every American taxpayer.
However, the Tax Cut and Jobs Act (TCJA) passed in 2017 overhauled the entire tax system. The standardized deduction is now pretty high for most Americans, and it is likely higher for you than itemizing all your deductions. Still, you should see if you have qualifying deductions so you can make an informed decision.
What Are Some Qualifying Deductions?
The IRS has a full list of what they consider itemized deductions, and this agency obviously is the final arbitrator on what expenses qualify.
You can deduct unreimbursed medical or dental expenses (i.e., medical expenses paid out-of-pocket) if the expenses exceed 7.5% of your AGI. This percentage will probably go up over time.
You can deduct interest paid on home mortgages for up to $750,000 of mortgage debt.
You can deduct certain taxes, such as property taxes. You can also deduct state and local income taxes up to $10,000.
Charitable deductions, up to 60% of your AGI, can be deducted if the donations go to qualifying charities.
The IRS will allow you to itemize certain other deductions, such as impacts of a natural disaster or losses from a partnership business. The TCJA also disqualified many expenses that previously could be itemized, so check with the IRS for specifics. Additionally, the details of the tax law change year to year, so either hire a tax professional or renew your research every year.
How Do I Itemize Deductions?
You calculate the total amount of your itemized deductions on the IRS form Schedule A and then enter it on your Form 1040. You file both documents with the IRS. You subtract the amount of total itemized deductions from your income amount to calculate how much tax you owe.
Should I Take Itemized Deductions or the Standardized Deductions?
As of 2020, the standard deduction for single filers is $12,400. This number may change depending on your income, filing status, marriage situation, and other factors. Because of inflation, the IRS is expected to increase this number in the future.
If you believe your qualifying deductions are higher than $12,400, you should itemize deductions. Otherwise, the standardized deduction is probably your best choice.